An Initial Public Offering or IPO is the first issue of shares by a private company. When a company decides to go public, it offers shares at a pre-determined price/price-band through the IPO.
Investors get an opportunity to become shareholders in the company and earn dividends if the company profits as well as capital returns if the demand for the shares of the said company increases. However, why do companies go public?
Every private company has a choice between staying private or going public. The Securities and Exchanges Board of India has laid down certain requirements that it needs to fulfill before launching an IPO which includes disclosing its financial records to the public. So, what are the advantages of going public? Are there any disadvantages too? How do investors benefit? Let’s find out.
In this article
- Advantages of Going Public
- Disadvantages of Going Public
- How Does Investing In an IPO Benefit Investors?
Advantages of Going Public
There are many reasons behind a company’s decision to go public. Here are some advantages that a private company can derive by launching an IPO.
1. Raising Capital
As the name suggests, a private company finances its operations through private funds – i.e. funds from its shareholders, investors, venture capitalists, etc. However, based on the sector and performance of the company, it can reach a stage where it needs a huge infusion of capital to expand, scale-up operations, or various other reasons.
While it approaches its shareholders and investors first, if they are unable to offer the funds, then the company needs to start looking at other options.While banks are an obvious choice, there can be a limit to the amount of funds they can offer based on their analysis of the company. Also, interest rates can hurt the company’s finances too.
The other option is going public. Since SEBI mandates all companies to disclose their complete financial information before launching an IPO, investors can analyze their performance before investing in them.
Imagine a company with four shareholders.They invest money in equal proportion and work hard to establish and grow the business. Five years later, the company is doing well and one investor decides to cash in on his investment.
While the shareholders can divide the profits, they cannot monetize the fame and goodwill of the company without going public.Once the company’s stocks are listed on the exchange, the price moves based on the general investor’s perception of the company’s performance.
Hence, all the effort made by the shareholders and/or employees in making the business successful gets paid back.This increases liquidity for existing shareholders.
3. Improves the Credibility of the Company
If a company is listed on a stock exchange, then you can be assured of a few things like the transparency of financial data since SEBI asks all companies to report it periodically, better management, etc. Hence, once a company goes public, its credibility usually improves.
4. Helps Assess the Company’s Market Worth
When a stock is listed on the exchange, it is worth only what an investor is willing to pay for it. Hence, it provides an insight into the company’s market worth. A company that has a good market worth can attract good talent and better options for acquisitions and/or mergers.
5. Gives Greater Market visibility
When a company launches an IPO, it garners attention from the public. People who have never heard about the company but invest in the stock markets start researching it and assessing its financials. This helps it gain market exposure.
Disadvantages of Going Public
When a company decides to go public, it’s not all rainbows and unicorns. Here are some disadvantages to going public:
1. Huge Upfront Costs
Launching an IPO involves a lot of costs including underwriting charges, legal fees, accounting costs, registration fees, advertising costs, etc. The company also needs to hire manpower specialized in the IPO process.
2. Loss of Autonomous Control Over the Company
In a private company, the shareholders have autonomous control over the business and its operations. However, once the company goes public, this control is lost. While most companies ensure that they keep the majority shareholding in the company, the minority shareholders can influence the decision-making process.
3. Forces the Company to Focus on Short-term Growth
Investors who purchase the shares of a company expect it to perform well. They want a good return on their investment within a relatively short span of time. If the company fails to do so, then the investor perception can turn negative, driving the stock prices down and impacting its sales too.
Hence, once a company goes public, it needs to pay special attention to its short-term growth. This can be counterproductive especially at a time when the company needs to keep a long-term view.
4. Increases Compliance Requirements
When a company goes public, its compliance requirements increase. From conducting audits regularly to publishing financial reports every quarter, the company needs to ensure that it meets all the audit requirements mandated by SEBI.
This means that the company needs to hire specialists regularly and absorb the increased costs too.
How Does Investing In an IPO Benefit Investors?
Let’s look at the benefits offered by an IPO to investors:
- Since an IPO is the first time a company issues shares to the public, investing in an IPO allows investors to become a part of the growth story of the companies they believe in.
- As the shares are being introduced in the market for the first time, their price is still unaffected by the market demand. Hence, if researched right, investors have an opportunity to earn short-term, as well as, get long-term gains.
While there are many other benefits of IPO to investors, access to good quality unlisted stocks is the primary reason behind people looking at IPOs.
As you can see, when a company goes public and launches an IPO, it has a lot to gain. With the stock markets being driven by demand and investor sentiment, a company that has strong fundamentals can reap several benefits by going public. While there are some drawbacks,companies deliberate thoroughly before making this decision.